Did Taxes Cause the Financial Crisis?
Conventional wisdom has resolutely rejected the view that tax systems' tendency to favor corporate debt over equity contributed to the global financial crisis. But, with the Obama administration planning to overhaul US corporate-tax policy, the tax system's potential impact on financial risk merits further consideration.
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CAMBRIDGE – After the financial crisis erupted in 2008, many observers blamed the crisis in large part on the fact that too many financial firms had loaded up on debt while relying on only a thin layer of equity. The reason is straightforward: whereas equity can absorb a business downturn – profits fall, but the firm does not immediately fail – debt is less forgiving, because creditors do not wait around to be paid. Short-term creditors cash out or refuse to roll over their loans, denying credit to financially weakened firms. Long-term creditors demand to be “made whole” and sue. Without cash, the firm fails.